What is a Money Market?
The term ‘Money Market’, according to the Reserve Bank of India, is used to define a market where short-term financial assets are traded. These assets are a near substitute for money and they aid in the money exchange carried out in the primary and secondary market. So, essentially, the money market is an apparatus which facilitates the lending and borrowing of short-term funds, which are usually for a duration of under a year. Short maturity period and high liquidity are two characteristic features of the instruments which are traded in the money market. Institutions like commercial banks, non-banking finance corporations (NBFCs) and acceptance houses are the components which make up the money market.
The money market is a part of the larger financial market and consists of numerous smaller sub-markets like bill market, acceptance market, call money market, etc. Money market deals are not carried out in money / cash, but other instruments like trade bills, government papers, promissory notes, etc. Also, money market transactions cannot be done via brokers but have to be carried out via mediums like formal documentation, oral or written communication.
Some Important Objectives Served By a Money Market
The money market serves several objectives in the overall economy. Listed below are some important objectives:
- The money market doesn’t only help in the storage of short-term surplus funds but also helps in lowering short term deficits.
- They help the central bank in regulating liquidity in the economy.
- Money markets help short-term fund users to fulfill their needs at reasonable costs.
- The money market helps in the development of the capital market, trade and industry.
- To help design effective monetary policies.
- To facilitate streamlined functioning of commercial banks.
What Are Money Market Instruments?
As the name suggests, Money Market Instruments are simply the instruments or tools which can help one operate in the money market. These instruments serve a dual purpose of not only allowing borrowers meet their short-term requirements but also provide easy liquidity to lenders. Some of the common money market instruments include Banker’s Acceptance, Treasury Bills, Repurchase Agreements, Certificate of Deposits and Commercial Papers.
Characteristics of Money Market Instruments
Money market instruments allow governments, financial organizations and businesses to finance their short-term cash requirements. Some of the notable characteristics of money market instruments are as follows.
- Liquidity – Money market instruments are highly liquid because they are fixed-income securities which carry short maturity periods of a year or less.
- Safety – Issuers of money market instruments have strong credit ratings, which automatically means that the money instruments issued by them will also be safe.
- Discount Pricing – Another important characteristic feature of money market instruments is that they are issued at a discount on their face value.
Types Of Money Market Instruments
Treasury Bills (T-Bills)
Issued by the Central Government, Treasury Bills are known to be one of the safest money market instruments available. However, treasury bills carry zero risk. I.e. are zero risk instruments. Therefore, the returns one gets on them are not attractive. Treasury bills come with different maturity periods like 3-month, 6-month and 1 year and are circulated by primary and secondary markets. Treasury bills are issued by the Central government at a lesser price than their face value. The interest earned by the buyer will be the difference of the maturity value of the instrument and the buying price of the bill, which is decided with the help of bidding done via auctions. Currently, there are 3 types of treasury bills issued by the Government of India via auctions, which are 91-day, 182-day and 364-day treasury bills.
Certificate of Deposits (CDs)
A Certificate of Deposit or CD, functions as a deposit receipt for money which is deposited with a financial organization or bank. However, a Certificate of Deposit is different from a Fixed Deposit Receipt in two aspects. The first aspect of difference is that a CD is only issued for a larger sum of money. Secondly, a Certificate of Deposit is freely negotiable. First announced in 1989 by RBI, Certificate of Deposits have become a preferred investment choice for organizations in terms of short-term surplus investment as they carry low risk while providing interest rates which are higher than those provided by Treasury bills and term deposits. Certificate of Deposits are also relatively liquid, which is an added advantage, especially for issuing banks. Like treasury bills, CDs are also issued at a discounted price and their tenor ranges between a span of 7 days up to 1 year. However, banks issue Certificates of Deposits for durations ranging from 3 months, 6 months and 12 months. They can be issued to individuals (except minors), trusts, companies, corporations, associations, funds, non-resident Indians, etc.
Commercial Papers (CPs)
Commercial Papers are can be compared to an unsecured short-term promissory note which is issued by highly rated companies with the purpose of raising capital to meet requirements directly from the market. CPs usually feature a fixed maturity period which can range anywhere from 1 day up to 270 days. Highly popular in countries like Japan, UK, USA, Australia and many others, Commercial Papers promise higher returns as compared to treasury bills and are automatically not as secure in comparison. Commercial papers are actively traded in secondary market.
Repurchase Agreements (Repo)
Repurchase Agreements, also known as Reverse Repo or simply as Repo, loans of a short duration which are agreed upon by buyers and sellers for the purpose of selling and repurchasing. These transactions can only be carried out between RBI approved parties Repo / Reverse Repo transactions can be done only between the parties approved by RBI. Transactions are only permitted between securities approved by the RBI like treasury bills, central or state government securities, corporate bonds and PSU bonds.
Banker's Acceptance (BA)
Banker's Acceptance or BA is basically a document promising future payment which is guaranteed by a commercial bank. Similar to a treasury bill, Banker’s Acceptance is often used in money market funds and specifies the details of the repayment like the amount to be repaid, date of repayment and the details of the individual to which the repayment is due. Banker’s Acceptance features maturity periods ranging between 30 days up to 180 days.Disclaimer
Mutual Fund investments will be subject to market risks. Any mutual fund listed in the document does not guarantee fund performance or its underlying creditworthiness. Do read the mutual fund document thoroughly before investing. Specific investment needs and other factors have to be taken into account while designing a mutual fund portfolio.
GST rate of 18% applicable for all financial services effective July 1, 2017.